Feature Story: Metals Benefit from the “Everything Shortage”

But a Short-Term Shakeout May Be Needed

 

Last week’s issue of Barron’s featured a story about the so-called “Everything Shortage”, an allusion to the worldwide shortage of essential goods across many different industries. If you know anything about inflation, you know that it has been classically defined as “too much money chasing too few goods.” With that in mind, the Everything Shortage is worth discussing since it will almost certainly have a big impact on precious and base metals prices in the coming months.

Blame it on the lingering impacts of last year’s Covid-related shutdowns, or blame it on a series of unfortunate weather-related setbacks (like Hurricane Laura and the polar vortex), but whatever the reasons, supply chains domestically and globally are in disarray. Because of the near-constant supply chain disruptions that have occurred since last year, supplies of many key commodities and consumer goods are harder to get in a timely fashion.

Nationwide transportation problems seem to be the major problem surrounding the shortage of goods. As the Barron’s article pointed out, “Shipping containers that carry most of the world’s goods are suddenly difficult to secure, but at the same time, Daniel Miranda, president of the Longshore and Warehouse Local 94 union that works two massive California ports, sees too many of them. ‘Your goods are on the dock, but who’s going to pick them up?’ he says. ‘If you don’t believe me, I’ll take you to L.A., Long Beach, and you can see them stacked eight high.’”

Last month’s temporary Colonial Pipeline shutdown (cyber-attack related) is another case in point. While gasoline supplies remained plentiful in the southeastern part of the U.S. served by Colonial, finding trucks to distribute it to fuel stations was a problem due to transportation bottlenecks and trucker shortages. Consequently, gas prices briefly spiked well over $3/gallon in some areas of the country.

As I alluded to above, the problem of inflation can be boiled down to a case of excess money supply chasing a diminished availability of goods—emphasis on availability. For it doesn’t matter that the actual supply of certain commodities is plentiful; what does matter is how easily that supply can reach its designated market channels. Transport problems represent a limitation of the supply of goods reaching the market, which can exacerbate inflationary conditions even in the midst of a plenitude of products.

“But,” observes economist Scott Grannis in a recent blog, “it’s important to remember that supply bottlenecks and temporary labor shortages are not what create inflation: only Fed mistakes do.” And the chief problem as he sees it?  “Massive government spending and an overly-accommodative Fed have introduced profound risks to the economy and to financial markets.”

Grannis further noted that the central bank isn’t reversing its quantitative easing (QE) policy in response to recent inflation signals, which means “unwanted money” is increasing. This of course can be seen in the weak U.S. dollar and rising commodity prices, not to mention accelerating house and stock price values and rising inflation expectations.

Adding pressure to the money supply aspect of the growing inflation problem, the White House envisions spending some $6 trillion in the coming year, “with trillion-dollar deficits as far as the eye can see,” as financial pundit Randall Forsyth recently observed. Economists and investors alike fear that inflation could accelerate in the coming months as a result of unrestrained fiscal spending and money supply increases, the extent of which is visible in the graph showing the runaway federal spending trend.

The explosive increase in federal expenditures shown above, coupled with shrinking tax receipts, is a recipe for future inflation. Not surprisingly, the market is already discounting the negative impacts to the economy via the inflation-index Treasury securities (TIPS) market. Based on current TIPS yields, the inflation rate is anticipated to average around 3% per year for the coming five years.

Shown here is a useful graph comparing the inverted 5-year TIPS yield with the gold price. Both tend to be positively correlated to each other since both gold and TIPS have long been used as safe havens whenever investors are worried about future economic prospects. As you can see, both the gold price and the TIPS inverted yield are near record highs, which underscores the extent to which gold’s “fear factor” is driving up the metal’s price.

As we head further into 2021, I expect to see more evidence that inflation expectations are increasing as supply-chain disruptions continue in parts of the world where Covid lockdowns continue. Importantly from an investment standpoint, the metals in general (and gold specifically) should benefit from this rising fear of inflation, much as they have for the better part of the last year.

In the short-term, however, a shake-out (or “pause that refreshes”) is probably needed to cool off some of the excess heat generated by recent rallies in the key industrial and precious metals. We’ll discuss this in greater depth elsewhere in this issue. But the overall intermediate-term (6-9 month) trend for the overall metals sector remains bullish.

What To Do Now
We recently purchased a conservative position in the iShares Gold Trust (IAU), my preferred gold-tracking vehicle of choice (and the most actively traded of the U.S. exchange-listed gold ETFs). IAU has rallied persistently in recent weeks as fears over inflation widened. There have also lately been substantial inflows into IAU ($291 million week over week, to be exact) as investors—retail and institutional alike—have increased their appetite for gold in the wake of economic and geopolitical concerns. While higher inflows in IAU can sometimes serve as a contrarian signal (thus hinting that a trend reversal is imminent), higher inflows can also be interpreted as a bullish development in the early stages of a turnaround. All told, I’m still expecting a fairly vibrant gold market this summer. I suggest raising the stop-loss on this position to slightly under the 35.30 level on a closing basis (where the 25-day line’s presence is currently felt). HOLD

Turning our attention to the leading blue-chip gold miners, Barrick Gold (GOLD), the world’s second-largest gold producer, is poised to benefit from the gold turnaround currently underway. Moreover, its copper exposure is also a long-term positive (along with declining per-unit copper mining costs). The million-ounce gold producer forecasts all-in sustaining costs for gold (a key metric) of around $929 per ounce as of last year’s fourth quarter—well below current prices of around $1,911 per ounce—and giving the firm plenty of room to take on additional projects. Also encouraging for Barrick is a balance sheet featuring zero net debt, $500 million in cash and a $3 billion undrawn credit facility. What’s more, the company trades at a reasonable price/earnings ratio of 17, which makes the stock attractively valued compared to many of its peers. After shares rallied 8% from our initial recommendation, I previously suggested taking partial profits (based on the rules of our technical trading discipline). For now, I also suggest maintaining the previously-recommended protective stop-loss on the remainder of the trading position at slightly under the 23 level. HOLD

An excellent balance sheet and solid production outlook combine to make Newmont Mining (NEM) one of my top picks among blue-chip senior gold mining companies. From a relative strength perspective, moreover, Newmont has been a leader in the present gold mining stock rally, having been the first of the senior miners to achieve new highs for the year in April. In a recent conference call, Newmont’s CEO stated, “During the first quarter, our world class portfolio produced 1.5 million ounces of gold and 317,000 gold equivalent ounces from copper, silver, lead and zinc. In line with our full-year outlook and positioning Newmont to deliver a stronger performance as expected in the second half of the year.” Analysts concur and expect Newmont’s top line to increase 37% from a year ago in the second quarter of 2021, while the bottom line is expected to increase 145%. Newmont’s all-in sustaining costs, meanwhile, are currently $1,039 per gold ounce, which is under current bullion prices by around 85%. It’s a solid mining story and I believe Newmont stock should be a part of every long-term precious metals portfolio. After the 10% rally from our initial recommendation, I previously suggested traders take partial profits and raise the stop on the remainder of the trading position. The suggested stop-loss for the remainder of our position is slightly under the 67.50 level (our original entry point). HOLD

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